Chan and Mi v Kai Design & Construction Pty Ltd [2014] ACTSC 86

5. If the security required by order 1 is not provided, the arbitration proceedings IAMA 5073 and 5074 are stayed until that security is provided.

1. This is an unfortunate case in that it involves two arbitrations relating to construction contracts for two single residential dwellings. A different aspect of the case has previously been subject of a decision of this Court: see Chan v Wood [2013] ACTSC 228. While the amount at stake in the arbitration proceedings is significant for the parties and significant in terms of the quantum of the original building contracts, the amount at stake are not such as to be able to support protracted litigation between the parties. Notwithstanding some considerable encouragement from me, the parties have been, as yet, unable to reach any settlement of the proceedings. In those circumstances, the parties are entitled to have their disputes resolved by arbitration and, to the extent necessary, by decisions of the Court. That is a course which involves very significant risks for the parties, not the least of which is the fact that the quantum of legal fees incurred on both sides will very soon dwarf the amounts at stake and will render it even more difficult for the parties to achieve some reasonable settlement.

2. In these reasons, I will refer to the plaintiffs (who are the defendants before the arbitrator) as the owners and the defendant (which is the claimant before the arbitrator) as the builder.

3. Section 47 of the Commercial Arbitration Act 1986 (ACT) provides:

1. General power of court to make interlocutory orders

The court shall have the same power of making interlocutory orders for the purposes of and in relation to arbitration proceedings as it has for the purposes of and in relation to proceedings in the court.

4. In Johnson v Macri & Marcellino Pty Limited (unreported, Supreme Court of New South Wales, 8 June 1990) Cole J held that s 47 of the Commercial Arbitration Act 1984 (NSW) empowered the court to make orders for security for costs. His Honour recognised that the position brought about by s 47 was different to that which had applied under the Arbitration Act 1902 (NSW) which was held in Holman v Dynabuild Pty Ltd (1975) 2 NSWLR 334 not to empower the court to make an order for security for costs of an arbitration.

5. The decision in Johnson was consistent with Victorian decisions to the same effect: see Mowbray College v Exhib Design & Construction Pty Ltd (in liq) (1986) 5 ACLC 478 and Nasic v Dimovski [1988] VicRp 12; [1988] VR 94.

6. The conclusion reached in Johnson has been followed and accepted in New South Wales both by single judges and by the New South Wales Court of Appeal: see Imperial Leatherware Co Pty Ltd v Macri & Marcellino Pty Ltd (1991) 22 NSWLR 653 at 666 and 667 per Rogers CJ Comm Div; FPM Construction Pty Limited v Wollongong City Council (2004) NSWCA 418 at [4] per Hodgson JA with whom Bryson JA agreed; ABB Service v Pyrmont Light Rail (2006) NSWSC 187 at [2] per McDougall J.

7. Having regard to the uniform nature of the legislation and the consistency of the decisions with the terms of s 47, in my view the decision in Johnson should be followed in relation to s 47 of the Commercial Arbitration Act 1986. As a consequence, the Court does have power to make an order for security for costs of arbitration proceedings being conducted under the Act.

8. The Court has power both under r 1901 and s 1335 of the Corporations Act 2001 to make an order for security for costs against a company where there is reason to believe that it will not be able to pay a defendant's costs if ordered to pay them. As Penfold J observed in Cleary Bros (Parramatta) Pty Limited v Commonwealth Bank of Australia (No 3) (2011) ACTSC 139 at [8], in relation to a corporation, the provisions of r 1901 and s 1335 are, in substance, the same.

9. I was referred by the parties to the decision of Black J in the matter of Re Pioneer Energy Holdings Pty Limited (2013) NSWSC 1366 which summarises the approach to be taken to the threshold issue in relation to security. Speaking in relation to the equivalent rule in the New South Wales Uniform Civil Procedure Rules, his Honour said at [5]:

I turn first to the question whether there is reason to believe (as contemplated by UCPR r 42.21(1)(d)) or credible testimony (as contemplated by s 1335) that BOE and BDA would be unable to pay the costs of the Second-Sixth Defendants if ordered to do so. This requirement will generally be satisfied if there is a real chance, in events that are reasonably possible, that the relevant corporation will be unable to pay those costs: Beach Petroleum NL v Johnson [1992] FCA 110; (1992) 7 ACSR 203 at 205; Deangrove Pty Ltd v Buckby [2002] FCA 1544 at [4]; ACN 105 921 962 Pty Ltd v Wiggett (2012) NSWSC 1526 at [4]. In Wollongong City Council v Legal Business Centres Pty Ltd above, Beazley JA (with whom Meagher and Barrett JJA agreed) observed that the Court should adopt a "practical commonsense approach" to the examination of a corporation's financial affairs (at [28]) and noted that the defendant bears the onus of establishing that there is reason to believe that the plaintiff will be unable to pay those costs if unsuccessful and, if that is established, the onus shifts to the plaintiff to establish a reason why security should not be granted (at [29]-[30]).

10. As von Doussa J explained in Beach Petroleum, the process of assessing whether or not the threshold is met will involve an element of speculation about the future and an assessment of the chance of different circumstances existing at the time when an order for costs becomes enforceable.

11. Mr Stretton, who appeared as counsel for the owners, identified ten matters which he submitted indicated that there was reason to believe, or alternatively credible testimony that the builder would be unable to pay the owners' costs of the proceedings if the builder was not successful. Mr Moffett, who appeared for the builder, addressed each of those ten matters. I do not intend to traverse each of those matters, however, I will refer to those matters which I consider to be most significant.

12. The builder is a company which was incorporated in April 2012 and has a share capital of $100. It does not own any real property. The evidence as to precisely what its assets are is not clear, although some of its assets, including at least two of its vehicles, are subject to registered securities. It is one of a number of corporate entities with which its director, Mr Li, is involved. The copy of the profit and loss statement and balance sheet for the builder for the financial year ending 30 June 2013, which was exhibited to Mr Li's affidavit, was not complete. It did not show any detail of the assets of the company because the first page of the balance sheet was not in evidence. The balance sheet shows a total equity of $115,856.36.

13. The liabilities of the company include an obligation to repay a loan to the director in the sum of $135,073.64. The profit and loss statement indicates that the total income of the company was $3,271,508.02. That was principally comprised of income from residential construction and work in progress. The net profit before income tax was $116,125.09.

14. Neither the accounts nor the affidavit explained whether or not Mr Li received some income from the company other than by way of a distribution of profit. The evidence of Mr Li was that he estimated that the annual turnover for the financial year ending 30 June 2014 would be in excess of $2 million. Assuming that the reference to turnover in that statement is a reference to gross income, that figure represents a significant decrease in the overall value of business undertaken by the company and, all other things being equal, would lead to a proportionally smaller level of profit. Bank statements of the builder were also tendered which give some indication of the current financial position of the builder. Those records show that although the builder had a significant volume of transactions going through its bank account, approximately $200,000 in each month other than January, it only had a nominal balance at the beginning and end of each month. The banking records are consistent with income closely matching outgoings. Mr Li includes in his affidavit the general statement that the defendant is solvent and capable of paying its debts when they fall due and will be capable of meeting any adverse costs order which might be made against it in the arbitration proceedings relating to the Franklin or Harrison properties. There is no evidence of the further financial resources available to the company other than from its trading income generated by its business activities. There is no evidence of availability of capital from other parties if that capital was necessary in order to meet an adverse order arising from the arbitration.

15. There does appear to have been some loans from its director in the past, although the circumstances of the accumulation of that liability is not made clear by the evidence and there was no evidence to suggest that a director's loan would be available to accommodate payment of a costs liability incurred by the builder in the arbitration.

16. In addition to any costs liability incurred in relation to these proceedings, there is a costs liability of the builder arising out of the earlier proceedings between the parties to which I referred above. That liability has not yet been crystallised in a judgment of the Court because the costs in question are yet to be subject to assessment. However, the bill has been drawn at approximately $79,000 and following an assessment, an amount involving a significant proportion of that is likely to be required to be paid by the builder.

17. In my view, there is a real chance that in events that are reasonably possible, the relevant corporation will be unable to pay the costs incurred by the owners in the arbitration proceedings. I reach that conclusion because the evidence discloses that the builder has only a modest net asset balance and a modest capacity to generate profit from its trading activities. In addition to its ordinary activities, it will be obliged to satisfy the costs order that was made against it in the previous proceedings and does not appear to have any reserves of significance to accommodate any adversities that may arise in relation to its operations.

18. On the evidence before me, it does not have access to any resources of its director and shareholder or any other person or entity. There is no material indicating how, within the scope of its resources, it is financing the conduct of the proceedings before the arbitrator. In those circumstances, either by reason of the conduct of the proceedings between the parties or due to some adversity in its trading circumstances, it is reasonably possible that the company will be unable to pay costs ordered to be paid by the arbitrator. As a consequence, I am satisfied that the threshold for making an order of security has been met. In reaching that conclusion I have taken into account the assertion by Mr Li in his affidavit that the company would be able to pay its debts when they fall due. However, I have given that statement little weight in the light of the objective material that is available to me. It may be that it will be able to pay the costs if it is ultimately, sometime after June 2014, required to do so. However, as I have indicated, on the objective material before me, it would only take a relatively minor adversity arising out of litigation or the ordinary hazards of being a small to medium size residential building company, to put the company in a position where it was unable to do so.

19. The factors to be taken into account in determining whether or not to make an order for security include those set out in r 1902. They are not exclusive. The arbitration relates to contracts for the construction of two properties, one referred to in the evidence as the Franklin property, the other referred to as the first Harrison property. In relation to both arbitrations, the owners are defending the claims and have lodged counter-claims. The arbitrations are listed for hearing from 17 to 24 June 2014. Those dates appear to involve six hearing days.

20. The dispute is a private commercial dispute in which claims and cross-claims have been asserted. I proceed on the basis that the claims made by the builder and the owners are each arguable and that there is no issue as to their genuineness. I have found that the threshold for making an order has been met but in exercising my discretion, I take into account the fact that it is not a clear case of insolvency or a situation where the relevant company has ceased trading.

21. The evidence is that the company is continuing to trade and there is no evidence indicating that it will cease to do so. No submission was made that the builder's lack of financial resources was attributable to the owners' conduct. Similarly, I do not consider that the builder is effectively in the position of a defendant. In my view, the evidence does not establish that the making of an order for security for costs would be oppressive or that it would stop or limit the progress of the proceedings. To place weight on either of these factors, there would need to be evidence indicating that the making of an order would cause real difficulties for the builder or that those persons standing to gain from the conduct of the proceedings, in particular Mr Li, did not have the resources to permit the security to be provided. It cannot be said that the proceedings involve a matter of public importance. There has been no admission by the owners or payment into court. There has been no relevant delay.

22. An order for costs against the builder would be enforceable within the jurisdiction. The estimated costs of the proceedings are likely to be substantial, although as indicated below, the evidence on this issue was less than ideal. Having regard to the approach taken by the defendant to the evidence in the proceedings, I consider it appropriate that the builder provide security for the owners in the arbitration proceedings.

23. The prospect of the plaintiffs having to rely on such security in order to recover their costs if they are successful is a real one and there is no sufficient basis in the evidence to persuade me that I should not make an order for security. The evidence outlining the costs recoverable by the owners in the event that they are successful in their defence of the claims made in the arbitration is contained in an affidavit of Mr Malicek, the solicitor for the owners. That evidence assesses the party and party costs of the Franklin arbitration as being $120,000 and the Harrison arbitration being $60,000, a total of $180,000.

24. Although there was some criticism of Mr Malicek's assessment, both on the basis of his level of experience in costs assessment as well as in relation to specific components of his assessment, the builder did not put on evidence to contradict his opinion, nor did Mr Moffett cross-examine Mr Malicek on the detail of his costs estimate. In submissions, counsel for the builder submitted that an appropriate estimate of the costs was between $50,000 and $60,000, although he did not make submissions that would suggest how that figure should be arrived at other than by taking a broad brush impressionistic approach. Having regard to the nature of the evidence and the manner in which the parties approach the issue of quantification, I do not consider it appropriate to engage in an item by item consideration of Mr Malicek's costs assessment. In deciding whether and to what extent to accept Mr Malicek's opinion, I take into account the fact that he has only practised as a solicitor for three years and has been involved in a modest number of costs disputes, only one or two of which have proceeded to an assessment.

25. I am satisfied that the costs estimate put forward in Mr Malicek's affidavit is too high. In my view the assessment:

(a) does not take adequate account of the related nature of the two claims and the previous involvement of the owners' solicitors in the earlier claim which provides a substantial amount of background to the current claim;

(b) overstates the likely recoverable rate of counsel's fees;

(c) appears to me to err on the side of generosity when assessing the steps necessary to be taken in the conduct of the proceedings having regard to the fact that the arbitration is listed in little more than a month; and

(d) includes substantial separate allowances for settlement negotiations and the conduct of a mediation in circumstances where no mediation has been directed and there is no proposal by either party to participate in a mediation.

26. In my view, an appropriate assessment of the quantum of security that should be awarded at this stage is an amount of $80,000. I make that assessment on the basis of the evidence before me noting that, consistently with the submission made by counsel for the builder, I should err on the side of a smaller award of security for costs because it will be open, if circumstances justify it, for the owners to make further application for security in the event that the ordered security is no longer sufficient. The parties appeared to proceed on the basis that I should make a single order for security in relation to both proceedings. I will hear the parties both as to the precise terms of the orders that I should make as well as whether or not I should make a single or separate orders for security or apportion the security in a particular way having regard to the existence of two arbitrations.

27. The parties were agreed on the orders required to deal with an application in proceedings by the owners dated 31 March 2014, which sought declaratory relief in relation to the Franklin arbitration.

28. Subject to any submissions as to the terms of the orders, in my view, the appropriate orders are as follows.

1. Within 21 days, the defendant is to provide security for costs in the sum of $80,000.

2. The security shall be provided by payment into a joint account in the name of the plaintiffs' and defendant's solicitors or by unconditional bank guarantee payable on demand made by the plaintiffs' solicitors or in a form agreed to by the plaintiffs within seven days of the date of this order.

3. The application in proceedings dated 31 March 2014 is dismissed.

4. The defendant pay the plaintiffs' costs of the originating application dated 13 March 2014 except that there be no order as to costs of the application in proceedings dated 31 March 2014.

[The parties were given an opportunity to make submissions about the proposed orders. After hearing the parties, his Honour made orders 1-4 as set out above as well as order 5 below.]

5. If the security required by order 1 is not provided, the arbitration proceedings IAMA 5073 and 5074 are stayed until that security is provided.

I certify that the preceding twenty-eight (28) numbered paragraphs are a true copy of the Reasons for Judgment herein of Master Mossop.